Exclusive: EBS take new step to rein in high-frequency traders

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Published August 23, 2013

| Reuters

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NEW YORK – One of the largest currency dealing platforms, ICAP's EBS, this week took a step to curb high-frequency trading on its network, the latest in a series of measures in the $5 trillion-a-day foreign exchange market to limit the perceived advantage of super-fast traders.

On Monday, EBS introduced a so-called "latency floor" - the industry term for trading speed - on trades in the Australian dollar/U.S. dollar currency pair, the fourth most actively traded cross.

Under the move, messages transmitting orders in the Aussie cross will be bundled into batches and then run through a process that randomizes their place in the queue. That could help level the playing field because the first message to hit the system will not necessarily the first order processed. The speed of the randomization process is between one and three milliseconds, EBS said. One millisecond equals one thousandth of a second.

High-frequency traders use powerful computer models to pump a large number of often small orders at a super-fast pace. For second-tier banks, asset managers and corporates who come to the FX market to do cross-border trade or hedge risks, this activity is making it harder to get the best prices before HFT firms.

Reuters first learned of the development from market participants, who declined to be identified, and an EBS spokesman later confirmed the move. Thomson Reuters Corp., the parent of Reuters, competes with EBS in foreign exchange trading through its Thomson Reuters Dealing platform.

EBS has informed market participants that it intended to extend the latency floor to the dollar/Swiss franc crosses, the fifth-busiest pair, as well after a period of assessment and analysis.

The growing prevalence of high-frequency trading has raised concerns about the fairness of markets and whether those with the fastest technology are putting others at a disadvantage or creating dislocations as a result of their speed. Currency platforms, which have players including banks and corporations, have recently shown resistance to allowing high-frequency trading to proliferate, and the head of EBS recently voiced his own concerns.

"We're not in the business of providing race tracks. We're providing a market for everyone," EBS Chief Executive Gil Mandelzis said in an interview with Reuters in late June. "We're not anti-HFT. We're against speed-only strategies."

HFT accounts for about 40 percent of spot trading in currencies, up from 3 percent a decade ago, according to an estimate from Boston-based Research firm Aite Group. By contrast, in U.S. equities, up to 70 percent of trading comes from HFT players and 45 percent in stocks globally, the firm estimates.

It is not the first strike against HFT by EBS. In September, under pressure from the banks that account for an estimated 70 percent of spot volume in the market, it reversed a decision to trade currencies in five-decimal increments, pushing it back to the traditional four seen in many exchange rates and scrubbing a system that had attracted HFT players.

One market participant who declined to be identified said it is difficult to measure the effect of the EBS move because its platform handles relatively little Australian dollar/U.S. dollar volume. The pair mainly trades on Reuters.

Among non-bank platforms, EBS is a leading liquidity provider for the Swiss franc, while Reuters dominates Australian dollar trading.

GREEN ROOM

Another effort to limit HFT is underway from ParFX, launched by Switzerland-interdealer broker Tradition in April.

It uses a so-called "Green Room" to assign a randomized pause to all order elements before matching, a process it says takes 20 to 80 milliseconds. ParFX is backed by 11 major banks, including the Bank of Tokyo Mitsubishi UFJ, Nomura Securities, Barclays, BNP Paribas, Deutsche Bank and Morgan Stanley.

Roger Rutherford, ParFX's chief operating officer, said this is the industry's response to "rising concerns that technology advantage should not automatically equate to trading, or economic, advantage."

"The market's telling us very clearly that the playing field should be genuinely level - regardless of location, technological sophistication or financial strength," he said.

Much of HFT volume takes place on major trading venues, including EBS, Thomson Reuters, Currenex, Hotspot FX and FXall, now also owned by Thomson Reuters. Some of the new FX platforms have also attracted sizeable HFT flows.

Critics say HFT uses their speed advantage to get between buyers and sellers, effectively scalping a spread that would have been available to other participants. HFT has also been criticized for creating the illusion of liquidity: HFT firms enter and withdraw large numbers of orders within milliseconds.

However, HFT firms argue that the competition is healthy in a market "that has for many years been the preserve of banks," said Remco Lenterman, chairman of the FIA European Principal Traders Association and a managing director of IMC, one of the world's largest HFT firms.

"In any industry new entrants will encounter resistance and the incumbent players will go through great efforts to limit the competitive advantage that these new entrants have," he said.

TRADER FRUSTRATION

Trader frustration at being outpaced by HFTs has contributed to the volume drop at EBS and Reuters in recent years.

Average spot FX trading volume on EBS fell 16 percent from a year ago to $89.3 billion in July, the lowest level since at least the beginning of 2006. At its peak in September 2008, EBS handled more than $270 billion in daily volume.

Thomson Reuters said daily spot FX volume declined to $114 billion in July on its dealing platforms, 12 percent lower from a year ago and down from a high of more than $180 billion recorded in 2010.

Phil Weisberg, global head of FX at Thomson Reuters, said the firm regularly monitors its venue rule books and "has always respected that various market participants have unique needs and as a result provides multiple venues."

Thomson Reuters recently changed the displayed price in the Mexican peso, South African rand and Russian ruble. Prices in these currencies are now quoted with the last decimal being either a zero or 5, rather than any digit between zero and 9. This means the market moves in slightly larger price increments and the firm said it has led to a reduction in disruptive behavior.